Barrett Business Services Inc (BBSI) 2015 Q1 法說會逐字稿

Good morning, everyone, and thank you for participating in today's conference call to discuss BBSI's financial results for the quarter ended March 31, 2015. Joining us today are BBSI's President and CEO, Mr. Michael Elich, and the Company's CFO, Mr. Jim Miller. Following the remarks, we will open the call for your questions.

Before we go further, I would like to take a moment to read the company's Safe Harbor statement within the meaning of the Private Securities Litigation Reform Act of 1995 that provides important cautions regarding forward-looking statements. The company remarks during today's conference call may include forward-looking statements. These statements, along with other information presented that are not historical facts, are subject to a number of risks and uncertainties. Actual results may differ materially from those implied by these forward-looking statements.

Please refer to the company's recent earnings release and to the company's Quarterly and Annual Reports filed with the Securities and Exchange Commission for more information about the risks and uncertainties that could cause actual results to differ.

I would like to remind everyone that this call will be available for replay through May 29, 2015, starting at 3 p.m. Eastern time this afternoon. A webcast replay will also be available via the link provided in today's press release, as well as available on the company's website at www.Barrett business.com.

Now, I would like to turn the call over to Chief Financial Officer of BBSI, Mr. Jim Miller. Please go ahead, sir.

Thank you, Camille. And, depending upon where you are dialing in from, good morning or afternoon, everyone.

As you saw at the close of the market yesterday, we issued a press release announcing our financial results for the first quarter ended March 31, 2015. The momentum we experienced in our business at the end of 2014 has continued into the first quarter. Our gross revenue expanded by 23%, supported by a 7.6% same-store sales growth.

In addition, we added approximately 229 net new clients in the quarter. This continued build speaks to the strength of our referral relationships as well as to the value our operational teams deliver in support of our clients.

We are maintaining our rolling 12-month outlook, due to the momentum in our current client base, the strength of our new business channels, and the scalability of our operations. In fact, the strategic investments in our infrastructure over the past several years have laid the groundwork for our performance and we are confident these investments will help BBSI's brand continue to mature in the marketplace.

Before taking you through our financial results, I would like to mention that yesterday's earnings release summarizes our revenues and cost of revenues on a net revenue basis as required by generally accepted accounting principles, or GAAP.

Most of our comments today, however, will be based upon gross revenues and various relationships to gross revenues because we believe such information is, one, more informative as to the level of our business activity; two, more useful in managing and analyzing our operations, and, three, as more transparency to the trends within our business. Comments related to gross revenues as compared to a net revenue basis of reporting have no effect on gross margin dollars, SG&A expenses, or net income.

Now turning to the first quarter's results, total gross revenues increased 23% to $896.9 million over the first quarter of 2014, primarily due to the continued build in the company's co-employed client count and same-store sales growth, coupled with a 17% increase in staffing revenues. Overall PEO gross revenues increased 24% over the first quarter of last year to $857.8 million, due primarily to the continued build in our co-employee client count and same-store sales. Our PEO revenues from existing customers increased approximately 7.6% year-over-year, due to increases in both headcount and hours worked. This compares to both a 9% increase in the same-store sales -- same quarter a year ago and last quarter being the fourth quarter of 2014 on a sequential basis.

Staffing revenues for the first quarter of 2015 increased 17% to $39.2 million, primarily due to an increase in new business and an increase from existing clients. On a percentage basis, the gross margin in the first quarter was 1% as compared to 1.3% for the first quarter of 2014.

The key drivers of this quarter's gross margin are as follows. Direct payroll costs as a percentage of gross revenues declined 21 basis points from 84.3% in the first quarter of 2014, which reflects an overall increase in the average customer markup percentage on a year-over-year basis. The company evaluates pricing on an as-needed basis to account for operational demand and market trends.

For the first quarter, payroll taxes and benefits as a percentage of gross revenues declined 17 basis points to 9.8%. The lower effective payroll tax rate for the 2015 first quarter resulted in a slight decline in overall state unemployment tax rates where BBSI does business and, to a small rising overall average wage rate, which allow the tax ceilings to be reached sooner in the year for 2015 as compared to 2014.

Workers compensation expense as a percentage of gross revenues was 5%, which compares to 4.4% in the same quarter a year ago. Looking at the remainder of 2015, we anticipate the level of workers comp expense to range between 4.8% and 5% of gross revenues. As expected, thy year-over-year percentage increase is due to an increase in the lost accrual rate, combined with increased costs from the full incremental expense associated with the (inaudible) program and surety bonds and letters of credit cost related to satisfying the security requirement for our California self-insurance program, which expired December 31, 2014.

The first quarter of 2015 represented the first full quarter of coverage under the Ace program, which provides workers compensation coverage to BBSI clients and their employees in California, replacing our self-insurance there. We have continued to offset these incremental expenses through price increases to selected customers.

During the first quarter, we closed an additional 93 claims from years 2012 and prior, resulting in approximately $900,000 of credit. This follows the progress we reported at December 31, 2014 and also supports the results we expected of the claims strengthening process initiated by the company. To date, this brings the closure of 585 claims or 45% of the total strength in claims from 2012 and prior, yielding $6.7 million in total credit.

Specifically, we are seeing a trend of claims from years 2012 and prior, closing for less than the amount put up on these specific claims. The significance of the 2012 and older claims is that they are now well-seasoned and, having been fully strengthened, provide us with a solid basis for analyzing the development of claim years 2013, 2014, and now into 2015. The number of total open claims from 2012 and prior is now less than 1,000.

SG&A expenses increased 18% to $17 million compared to $14.4 million in the first quarter of 2014, primarily due to higher management payroll, increased IT spend, and other variable expense components within SG&A to support continued business growth. Consistent with the second half of 2014, the increased IT expense relates to projects designed to enhance access and delivery of information to the field as well as improve efficiencies over time.

It is important that we prudently invest to stay in front of our expansion. However, we continue to target the rate of SG&A to grow in line or less than our gross revenue growth.

The benefit from income taxes in the first quarter was $3.3 million, which represented a tax rate of approximately 36.4%. We expect the tax rate for the balance of 2015 to remain in the mid- to upper 30s range. Net loss for the first quarter of 2015 was $5.8 million compared to a net loss of $3.6 million for the first quarter of 2014. Diluted loss per share for the first quarter of 2015 was $0.81 compared to $0.50 for the first quarter of 2014.

Consistent with our historical experience the (technical difficulty) [net] loss for the first quarter is largely due to the seasonally higher burden of employment taxes during the first several months of our year.

Now, turning to the balance sheet, our cash, cash equivalents, marketable securities, as well as restricted securities totaled $248.3 million compared to $239.1 million at December 31, 2014. At March 31, 2015, we had approximately $5.8 million drawn on our $14 million revolving line of credit.

During the first quarter, we funded approximately $28 million of cash into the Ace Trust account to supplement our $50.1 million of deposits at December 31, 2014 for our Workers' Comp insurance arrangement with Ace. These funds are included as a component of restricted marketable securities at Workers' Compensation deposits and our long-term assets with a portion representing an estimate of injury claims to be paid out in the next 12 months, which are included in the current assets on our balance sheet.

As we have commented on prior calls, the balance in the Ace Trust account is expected to build throughout 2015. We project that most of the funding for 2015 will come from the expense we accrue except for perhaps an estimated $10 million of free cash, which may be needed to meet the funding requirements for the balance of the year.

The $114.3 million of restricted certificates of deposit within long-term assets represent cash secured letters of credit to satisfy collateral requirements associated with surety deposits for Workers' Compensation purposes in the state of California, related to our expired self-insurance program. As I mentioned on last quarter's call, we expect the level of these restricted certificates of deposits to decrease by approximately $25 million by late 2015 at the outstanding California self-insured liability.

These deposits secure is now in a runoff mode. Upon reduction, a decreased portion will revert to an unrestricted status and become a current asset.

As I also mentioned on last quarter's call, I believe it is important to note that, while the optics of our current ratio did not appear strong, the cash generated from the operations of the business is sufficient to fund the daily needs of the company. Additionally, most of the current portion of long-term debt does not come due until the end of 2015, which will be funded primarily by income tax refunds and cash flow generated from operations throughout the remainder of 2015.

We generated approximately $5.5 million in operating cash flow during the first quarter of 2015 as compared to $7.7 million in the same period last year. Please keep in mind, however, that the cash flow for the first quarter of 2015 add back approximately $7.6 million of increases to the Workers' Comp and safety incentive liabilities that we accrue, but do not immediately pay out.

As we introduced last year, in order to provide our investors with a more appropriate forward-looking view of our business, we have initiated a rolling 12-month outlook for gross revenues which we plan to update on a quarterly basis. As such, we continue to expect gross revenues for the next 12-month period to increase approximately 18%. Included in this expectation is a high single digit contribution from same-store sales growth as well as growth from new business consistent with current trends.

I look forward to addressing you again on our second-quarter earnings call. Now I would like to turn the call over to the President and CEO of BBSI, Mike Elich, who will comment further on the recently completed 2015 first quarter as well as our outlook for (technical difficulty) [2015]. Mike?

Good morning and thank you for taking time to be on the call. Very pleased with results of the quarter. We continue to make significant progress in all areas. We saw progress through continuing the maturation of our brand as measured by level of growth we see across all markets. We continue the progress of maturing our organizational structure and processes by which we attract, develop, and retain people, and we continue to mature systems and integrate resources designed to support predictability in the model while bringing increased efficiencies to operations.

From looking at the quarter, we added 287 new PEO clients. We lost 58 PEO clients. Three were due to AR issues. Seven were canceled for non-AR issues and lack of tier progression. 19 businesses either sold or were closed. And 29 left due to pricing to competition or companies that moved away from an outsourced model, taking payroll in-house. This represents an approximate net build of 229 new clients. I believe that is a new record for us.

With same-store sales, we saw an increase of 7.6. Specifically, this measures hiring and increased of hours worked and our wage inflation. Measuring sequentially, fourth-quarter 2014 versus first-quarter 2015, we saw 39% of our clients add new headcount while 35% of our clients reduced headcount, with 26% unchanged. Related to pipeline and regional growth, we continue to see momentum and maturation of our brand as evidenced by the continued strong pipelines and ongoing interest in our offering. Our general market outlook is strong as we consistently -- as seen by consistency in our client build across all regions with increased momentum coming from the Northwest and Mountain states.

Related to structural -- structure in organizational build, we continue to expand the business -- and build business units to support our current and future organizational needs to meet market demand. Currently, we have 37 business units supported by 54 branches. We currently have two business units built with an additional 10 business units forecasted to be live by the end of 2015 with approximately -- for approximately 48 business units.

We also continue to see positive momentum with new markets opened in recent quarters while we see the potential to open two additional markets in 2015 or early 2016. Markets may range from additional expansion on the East Coast to future tuck-ins in the Western third of the United States.

Related to systems, we continue to focus on the integration and adoption of system development over the past 18 -- systems developed over the last 18 months with completion -- to complement our brand as well as to bring efficiencies to operations. We also continue to invest in systems -- and will continue to invest in systems through 2015 and into early 2016 to scale and support the future growth of the organization.

Related to workers comp and at the underwriting of risks, in the quarter we saw relatively flat frequency of claims as a percentage of payroll as compared to first-quarter 2014 and a decrease of about 5% compared to first quarter of 2013. Also in the quarter, we continue to see positive claim closures as evidenced by the continued increase in the percentage of claims closed over the past three years. We also continued to see a decrease in severity as evidenced by the trend of ultimate severity for claims -- claim years 2013, 2014, and 2015.

Moving forward, we will continue to monitor trends as to maintain a proactive positive relationship -- position related to Workers' Compensation, resulting in a greater predictability within the model. As I look at the company today, I am very pleased with the progress we continue to make on how we go to market and the ongoing maturing of the organization while reaching new thresholds year-over-year.

Today, we believe we have a fairly long runway in front of us with respect to our ability to build and retain our client base as well as with brand strength and maturity. The basis to our business is our organizational structure and, in the first quarter, we continued spending a great deal of time with how we develop our bench strength. We also saw progress in the adoption of systems and processes that will allow us to strengthen engagement with our client base. As our teams mature and share best practices across markets, we continue to see more consistency in our brand and broader contribution from the entire organization. I look forward to see the companies maturing over the next several years.

With that, I will open it up to questions.

(Operator Instructions) Jeff Martin, ROTH Capital Partners.

Mike, could you touch on the geographic performance of the PEO business? How did California do versus the East Coast?

Looking at just the percentages of growth, California as a whole, both Northern and Southern, was right around that 21% to 22% up. What we did see is that East Coast -- well, all other regions, be it Northwest, Mountain states, and East Coast, were up in excess of 25%, even 30% for the most part.

Okay. Great. And then, could you touch on, as the business expands and just to grow back in the high teens, low 20% range, how easily is it to find management talent and branch manager talent and are you running into any hurdles there?

No. One of the things we are looking at is cap utilization, which is, if we look at structure today and we look at our operational capacity used today, we are probably maybe 50%, maybe even a little less than 50% of cap utilization. And as we are looking at our build of new clients up against markets across the board, we feel that we are probably 18 months out in front of our curve. We have also refined recently -- and just in the last couple of years -- our pipeline of how we attract, how we are recruiting, how we are bringing people on board. But, more importantly as well, how we are developing people once they are on board.

We have built systems that, today, are much more mature than they have been in the past to bring predictability to how long it takes us to find people and then, ultimately, how long it takes us to get them up to speed to be able to accommodate the expansion and growth in markets. So I feel we have got a pretty good runway out in front of us and we have got probably -- we are probably out in front of it maybe 18 months today. If you go back a couple of years, we were getting a little bit tight.

Right. Switching gears to the Workers' Compensation, you came in at the higher end of that 4.8% to 5% range for the first quarter. Could you help people characterize and understand how that will trend over the course of the year and what are some of the components that might cause that to come down over the course of the year?

Yes, Jeff, I think second, third, and fourth quarters, as there is more volume, some of those expenses are more of a fixed nature and they should be diluted down a little bit over the coming quarters. And we expect that the 5% will be on the high end of what we see. But, overall, I think the first quarter, the expense components came in pretty close to where we thought they would be.

Okay. Are you able, Jim, to quantify the fixed dollar amount in the workers comp component? Because there is some administration associated with the [Ace] and the surety.

Right. Right. Looking at the fixed piece of it, it is probably around 15% to 20% of the overall cost structure. A lot of that in 2015 probably just 10% of that is going to be the costs associated with the surety bonds and the letters of credit that we had to post at the end of 2014. So those costs are probably the single biggest component and probably close to nearly 10% of the overall cost.

Okay. And do I understand correctly that surety and letters of credit is only tied to the self-insured portion of California that tails off?

Correct. Right. So as we look out into 2016 and 2017, those costs will continue to decline in terms of [real] dollars.

Okay. Helpful. And then, in terms of cash flow, can you give us a ballpark of maybe a fairly loose range of what you expect in terms of free cash flow for the year?

Yes. So frequent free cash flow should approximate net income for the balance of the year and we are able to grow at the high teens the way we should have free cash probably exceed net income by a little bit, maybe 10%.

Matt Blazei, Lake Street Capital Markets.

Nice job on the quarter. Just a clarification on the Workers' Comp progress for these claims prior to 2012. I think last quarter you said that you had started with 1,800 open claims of which 1,300, I guess, needed to be strengthened, et cetera. And you had closed 492 of those during the course of 2014. Is that correct?

Right.

And that you closed another, I think you said, 90 -- 93 this quarter.

Right.

So you are somewhere -- I guess at this point, somewhere around 600 claims still open for 2012 and prior?

In total, it is right -- just slightly less than 1,000 claims.

And is that -- have there been claims added to that, then, from the end of the year or is it just -- is my math wrong?

No. There would be no claims added. Typically, when you have years that are at this point nearly three years or at the very youngest would be three years -- but, in some cases many years old, there is typically, once you get out a couple of years, your claim count is pretty well known and you don't typically have claims coming in that late.

Right.

And we have one area, too, we have talked about claims that were strengthened and the runoff of those versus the total claims that we had for 2012 and prior. Of the claims that we strengthened, we have had more of a runoff. So if there was 1,300, there is less of those. But there were other claims that were never strengthened that were in that 2012 and prior pool that are making up to the balance of that 1,000.

I see. And do you have -- so you did 92 -- you closed 93 of them this quarter. Is that sort of a quarterly run rate that you are shooting for or is that possible to tell or any idea in terms of what you would like to -- where you would like to be at the end of 2015?

It is kind of a balance of activity and what you can get done, based on what claims will let you do. First quarter is always going to be a little bit lighter, just because of the seasonality of the way January and February work. You tend to see more claims close in the fourth quarter. It is Christmas money. People are trying to close out the end of the year. People trying to put stuff behind them. So you'll have a little bit of seasonality in the process.

But we look at the year, it will probably be a little bit more than the 93 per quarter, but it should be at least that consistently and probably more so. It will be probably between 400 and 500 claims in the year, I would suspect. It just -- it depends. It is not -- you have got to be careful, too, that you are not just forcing closures to -- you can get all of them closed for a price. And our job is to make sure that we are getting optimum value out of what we can as we are trying to run that off.

And so, if you are able to do that, just in a rough number, does that mean at that point will have closed, say, 70% of the claims from 2012 prior?

Yes. 60% to 70%. Yes.

Yes. Probably.

Okay. Thank you. Good. I think that's it for me right now. Great quarter, you guys. Nice job.

(Operator Instructions) Bill Dezellem, Tieton Capital Management.

A couple of questions. First of all, you mentioned that you may have East Coast expansion in your 2015 plans. Would you talk a little bit more about how you are looking at East Coast expansion, not only this year, but beyond?

Well, as we look at how we have expanded and recently how we have opened new markets on the West Coast, what we find is that, as you have markets that are growing, we try to keep a lot of our business and/or our concentration of business around 50 miles of an existing branch. What happens, though, is as our referral channels expand; as our brand expands, it pulls us beyond those levels and beyond those points mileagewise.

And, over time, when you -- take a Baltimore market. You have got an opportunity there to build and concentrate yourself in that market where you can do -- you can have a lot of business because there is a lot there. But now, all of a sudden, you are getting pulled south into the DC area. That would be a great place to now open and put another stake in the ground and build another team to support that business as you are getting pulled south or even maybe north up into the Wilmington and Philadelphia area.

So that is the design of how we expand in a new market. And then, there is greenfield markets that we will look at just because we feel that it is a good investment. Or we have a customer or a block of customers that are pulling us in that direction.

But, as we look at just the East Coast, the momentum that we have there now, we are going to continue to capitalize on that and stairstep wherever we need, probably taking the Eastern Corridor from Baltimore down south towards -- into Charlotte and filling in that gap and even going further south towards -- into the South Carolina and maybe even into Georgia over time.

That's helpful. Thank you. And then, we spent a fair amount of time on the call talking about the pre- or the 2012 and prior claims as that had not been closed. Would you talk a little bit about the post-2012 claims and the rate of closure relative to what the company had done in the past?

Yes. So we've -- over the last year or so, we have seen an increased closure rate on the newer years being 2013 and 2014. And even starting in 2015 as well, compared to the closure rates we had experienced, say, back in 2011 and 2012. So certainly, one of the goals is to keep the number of open claims at a very manageable population and not let that continue to grow, even though the growth in overall business is very healthy.

So by maintaining those closure rates, stronger closure rates will help us maintain that level of open claims that is at a manageable rate. And so, by looking at the 2012 and prior claims as they close out, it is certainly giving us confidence that everything else being equal, looking at 2013 and 2014, and what we are seeing so far is that those are maturing as expected, it gives us confidence that what we are doing is working.

Another way to look at it as well is, we have changed practice and coming at things a different way over the last, probably, call it, 18 months to two years. Prior to that, we continued to see a build in our overall claim count where -- and roughly the last 12 months we have seen where that total claim count of what is open has become narrowly banded or has not moved much. So what that means is we are having new claims coming in. They are closing out faster and then we are also taking out of the base of claims that we have had historically in the past. So our total claim count is not building compared to where we had seen probably prior to 2012. And maybe even 2013.

That's helpful. And, just for clarification, at some point in the future, when you have fully dealt with the 2012 and prior claims, and then you have what I guess I will consider a new closure run rate on the newer claims, we should then see your -- or should expect your total claims count to increase as your business increases.

Yes and no. If we are continuing to close on the front end of the more simple claims, efficiently, and then recognizing what we should be able to close in the front year, be it 2015 and then 2014, one would think it should -- the claim count -- the total base should grow at the rate of growth in the business, but we kind of believe that we should be able to hold that number pretty consistent if we are doing what we are doing.

So you feel like you have more runway in terms of efficiency on the claims closure front essentially is what you are saying, before you hit that point where claims would grow with the business.

When we look at the efficiency we have built into the system right now, we are not seeing a build on claims. So, as we run off more of the older claims, the newer claims and the way we are managing them, that efficiency itself is actually keeping our claim count pretty consistent.

That's very helpful. And then, taking it one step further, and then I will step out of the queue, are you finding that the training and safety programs that you are putting in place is leading to fewer claims on the front end? Because there are just simply fewer accidents taking place?

I think it is combined with that. It is combined with the owner -- the engagement that we have with the overall model with our -- that starts with the owner of the company that is much more than just risk management, but it is really true risk mitigation that starts with employment practices, what we are doing on our HR basis, how we are measuring progress, how we are on top of issues that might be systemic to the clients that we are working with, and how we are engaging with the client on a proactive basis before a claim ever happens.

Think of it as being quality improvement process whereas we are working with the client. We are building out the symptoms that would lead to a claim proactively more up line which is leading to, one, a cleaner client base, and it is also leading to what we see as less frequency in the individual client. So it is all the things working together and it is the true model of what we are doing, but it builds out total employment defect, which includes Workers' Comp.

And, as a result, over time, your Workers' Comp extends as a percentage of gross revenues should be decreasing and not in the near term, but over a multi-year period?

That would be the plan.

Thank you.

Matt Blazei, Lake Street Capital Markets.

I knew I had one more question related to my Workers' Comp question earlier. But I know that in Q3 when you took the charge to increase the reserves, you felt that you were being very conservative in your sort of estimates' potential liability and it looks as if, from the closure -- the success you have been having on the closing side, I think you had a $5.8 million credit for last year's versus $5.6 million versus expectation, you said you had another $900,000 credit this quarter.

Assuming that that sort of ratio continues the rest of the year, you are starting to build up a pretty sizable credit relative to the reserve charges you took. Is there a time at some time in the future that that gets recognized? Or somehow flows back to the income statement again? Can you help me understand that?

Yes. Sure. At some point, if that trend continues and, obviously, it depends on how 2013 and 2014 and now 2015 develop, but with the improvements we have made to the process and should these credits continue, certainly at some point in the future we might be in a position where we have to take credits back because there is no place to put all that liability.

We are still, though, in talking with our actuaries -- we are still early in the process and we are certainly very cautious about that situation happening too soon. But, something we will continue to monitor and have internal discussions about, for sure.

That does conclude our question-and-answer session. I would now like to turn the call back over to Mr. Elich for closing remarks.

Again, thank you for being on the call. Thank you for continuing to follow us. We feel very good about where we are at. I know 2014 was a year of shaking things out, growing up quite a bit, and very pleased with the progress we have made in the last 12 months. Things are looking good and you are always looking around the quarter to figure out what is out there, but the business over time continues to become much more predictable as we mature, grow up, as our senior bench grows and matures. I think that we have much more visibility today than we have ever had and so we are looking forward to the future and looking forward to follow-on quarters. So thank you for being on board. Bye.

Once again, that does conclude our call. Appreciate your participation.